Tuesday, August 30, 2011

Epistomological Crapshoot

by digby

I keep coming back to the Iraq war and how it played out in American politics over the course of several years. That sense of surreality, the helplessness, the fact that there were people out there telling the truth and expressing their reservations and nobody listened. The blogospheric trope Very Serious People was born from this odd phenomenon of a large number of the smartest people in the world getting everything so very wrong --- while systematically marginalizing those who got it right. I wouldn't have believed it if someone had said it would happen again in just a few years, but it did.

Today, John Aravosis is featuring an interesting interview he did with Joseph Stiglitz that is relevant to this topic:

"The way I would put it is, the hopes of the 'green shoots' that were expressed in March, 2009 that then turned to brown later in that year, and again woke up earlier this year, have again been dashed. So that the administration's, and the Fed's, constant referral to the economy 'on the road to recovery' is another demonstration of their inability to make economic judgments. Just like the Fed totally misjudged the economy in the period leading up to the recession, totally -- even after the bubble broke, they said the crisis was contained. Once again the Fed has shown that its ability to make judgments about the economy leaves something to be desired."

Now there are many (among them myself on odd numbered days)who think this is less an issue of competence and more an issue of intent. It's hard to believe that such smart people can be so wrong --- perhaps they simply have another agenda. Certainly, there is plenty of evidence of corruption, regulatory capture and all the rest to merit the suspicion. But then I see something like this Bill Gross apologia, and think there is something more mysterious going on.

Bill Gross, who runs the biggest bond trading firm in the world, is considered by many to be the smartest financial mind on the planet. In fact, among financial types, the bond traders of his caliber are often thought of as the Mandarins,as opposed to the cowboys in the stock market or the egomaniacs in the hedge fund world. This is supposed to be where the really smart guys go. And yet Bill Gross made a huge bet this past year --- the same bet the Obama administration did --- that went very wrong:

PIMCO's Bill Gross admitted his mistake over US bond call

In January 2011, Gross told CNBC that US Treasurys were "the most overvalued bond in the universe," arguing one should stay away from it, but not necessary from all kind of bonds.

"Don't stay out of bonds… stay out of Treasury bonds," he said then.

A few months later, he was the first to admit that his predictions did not come true.

"When you’re underperforming the index, you go home at night and cry in your beer,” Gross said, according to the FT, adding: “It’s not fun, but who said this business should be fun. We’re too well paid to hang our heads and say boo hoo.”

Reactions were soon to follow.

"Obviously, it's a bit of a mistake," Guy Lebas, chief fixed income strategist at Janney Montgomery Scott, told CNBC on Tuesday. "Treasurys make up roughly a quarter of the US bond markets, so saying we're going to completely abandon them in a fund as large as the one Bill Gross runs is a huge bet, and it's a huge bullish bet on the credit market, it's a huge bearish bet on the bonds," he said.

Gross's expectations have clearly not gone through, Lebas added, "but economic conditions have deteriorated far faster than PIMCO, or even we ever anticipated."

Gross wasn't a politico making some kind of ideological point. He lost a lot of money for his rich clients on that bet. And it was a bet that a fair number of people said at the time (including dumb old me, who has the financial savvy of a spider mite)was inexplicable. But he believed the hype, and in doing so, he convinced a whole bunch of other people that it must be right. After all, he's one of the oracles --- a Very Serious Person of the highest order.

So, I'm not convinced that this phenomenon is all about corruption. Sure, there's a lot of it. The government and Wall Street is a revolving door and the dependence on big donors is corrupting in and of itself. But I don't believe Bill Gross made that bet in some corrupt bargain to weaken the American political system at the behest of his fellow elites. There was just too much money involved. He screwed up. And he screwed up because he believed something that wasn't true despite a whole lot of evidence that it wasn't.

Gamblers make bad bets. Nobody wins every hand. But this one had huge ramifications to government policy because the person who was making it is such a revered person in the field. And because there has been so much of this over the past few years, among so many different members of our elite world leadership, I've finally concluded that it must have as much to do with epistemology as psychology or character. There is a systemic flaw in the way our elites are processing information and understanding the world around them. They may be hampered by their cramped social caste and worldview, and corruption is not a negligible factor, but the problem is obviously bigger than that. And I haven't got a clue about what it is.

Here's hoping that it's self-correcting, because one thing is clear --- the people in charge don't know how to fix anything and refuse to listen to those who do.